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DFARS Proposed Rule Provides Guidance on Indirect Offset Costs

The Department of Defense (DoD) on November 4, 2016, published a proposed rule to amend the Defense Federal Acquisition Regulation Supplement (DFARS) and implement statutory changes related to costs associated with indirect offsets under foreign military sales (FMS) agreements.

June 2015 Interim Rule

The DoD published an interim rule on June 2, 2015, that amended DFARS 225.7303-2, Cost of Doing Business with a Foreign Government or an International Organization, by providing guidelines to contracting officers when an indirect offset is a condition of a FMS contract. Steptoe’s advisory on the interim rule is available here.

The 2015 interim rule said all offset costs that involve benefits provided by the US defense contractor to the FMS customer that are unrelated to the item being purchased under the Letter of Offer and Acceptance (LOA) are deemed reasonable for purposes of FAR part 31 with no further analysis necessary on the part of the contracting officer, provided the contractor submits to the contracting officer a signed offset agreement or other documentation showing the FMS customer made the provision of an indirect offset of a certain dollar value a condition of the FMS acquisition. As a result, FMS customers are placed on notice through the LOA that indirect offset costs are deemed reasonable without any further analysis by the contracting officer.

Key Changes in the Proposed Rule

This new proposed rule expands on the earlier interim rule and incorporates the requirements of Section 812 of the National Defense Authorization Act (NDAA) for Fiscal Year (FY) 2016. Section 812 amended 10 U.S.C. 2306a(b)(1) to state that submission of certified cost or pricing data shall not be required in the case of a contract, a subcontract, or modification of a contract or subcontract to the extent such data:

(i) Relates to an offset agreement in connection with a contract for the sale of a weapon system or defense-related item to a foreign country or foreign firm; and

(ii) Does not relate to a contract or subcontract under the offset agreement for work performed in such foreign country or by such foreign firm that is directly related to the weapon system or defense-related item being purchased under the contract.

In response to public comments on the interim rule, the proposed rule also adds definitions of ‘‘offset’’ and ‘‘offset costs’’ at DFARS 202.101 for clarity:

Offset means a benefit or obligation agreed to by a contractor and a foreign government or international organization as an inducement or condition to purchase supplies or services pursuant to a foreign military sale (FMS). There are two types of offsets: direct offsets and indirect offsets.

(1) A direct offset involves benefits or obligations, including supplies or services, related to the item being purchased. For example, as a condition of a foreign military sale, the contractor may require or agree to permit the customer to produce in its country certain components or subsystems of the item being sold. Generally, direct offsets must be performed within a specified period, because they are integral to the deliverable of the FMS contract.

(2) An indirect offset involves benefits, including supplies or services, unrelated to the item being purchased. For example, as a condition of a foreign military sale, the contractor may agree to purchase certain manufactured products, agricultural commodities, raw materials, or services required by the FMS customer, or may agree to build a school or road. Indirect offsets may be accomplished without a clearly defined period of performance.

Offset costs means the costs to the contractor of providing any direct or indirect offsets required (explicitly or implicitly), as a condition of a foreign military sale.

The preamble to the 2015 interim rule noted that the DoD “recognizes the need to have offsets embedded in DoD FMS contracts.” In addition, FMS programs maintain and strengthen relationships with partner nations and further national security. That preamble stated the decision whether to engage in indirect offsets and responsibility for negotiating and implementing offset arrangements ultimately reside with the FMS customer and the contractor. A DoD contracting officer is not provided the information necessary to negotiate cost or price of indirect offsets, particularly with respect to price reasonableness determinations under FAR part 15. As a result, the interim rule and now this proposed rule provide that when an indirect offset is a condition of the FMS acquisition, the indirect offset costs are deemed reasonable for purposes of FAR Part 31, provided the contractor submits to the contracting officer an offset agreement or other substantiating document. This clarification is a positive step towards making FMS procurements proceed more quickly.

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